Can I do it? What are the rules?

By Maggie Polisano, Co-Founder, CamaPlan LLC

Airbnbs are popular investments and excellent additional revenue streams for property owners. The right property can make double or triple the cash flow of a long-term rental if you instead furnish it, add some guest amenities, and position it as a short-term rental on peer-to-peer platforms like Airbnb or VRBO. With a modest portfolio, even average investors can become boutique hoteliers.

But what about holding real estate in an IRA or 401(k) and operating an Airbnb in these tax-advantaged retirement accounts without incurring penalties, fees, or extra taxes?

First the basics: Real Estate in an IRA/401(k)

First things first — many people don’t know you can invest in real estate using IRA or 401(k) funds. So let’s brush up on the basics.

Self-Directed IRAs and Solo 401(k)s

Most IRAs and 401(k) plans are managed by institutional financial advisors. They will definitely tell you that you can’t put real estate in an IRA or 401(k) — but that’s not because it’s against the law.

“They only tell you that because they can’t earn a commission by selling you real estate,” explains Maggie Polisano, founder of self-directed IRA custodial service CamaPlan LLC. “It’s like the Dr. McCoy joke from Star Trek — ‘I’m a stock broker, Jim, not a realtor!’”

The truth is, the tax code allows you to hold real estate in an IRA or 401(k), as well as other asset classes not traded by the traditional financial advisor who established your account. Companies like CamaPlan offer self-directed IRAs and solo 401(k)s for that purpose.

If you have an IRA managed by the Smith Barneys or Wells Fargos of the world, you can transfer IRA funds to a self-directed IRA at will, without penalties or taxes. It just has to be the same type of IRA — Roth to Roth, SEP to SEP, etc. If you try to transfer Roth to SEP, it will be treated like a disbursal and subject to taxes and penalties.

A solo 401(k) is trickier, since it is established by your employer. However, if you leave your employer and have the opportunity to keep your accumulated 401(k), that’s when you can roll it over to a solo.

Unrelated Business Taxable Income (UBTI)

People who want to invest in real estate with IRA or 401(k) funds need to be aware of the little-known Unrelated Business Taxable Income (UBTI) rules. This is a section of the tax code that imposes taxes on income that is determined by the IRS to be “unrelated” to the purpose of stockpiling money for retirement — which is all you’re supposed to do with an IRA or 401(k).

“UBTI is the ‘gotcha clause’ of self-directed IRA and solo 401(k) shenanigans,” Polisano said. “If you try to get cute with your tax-exempt or tax-deferred retirement money, the IRS will tax it using UBTI. It really defeats the purpose of an IRA, which is there to protect your retirement savings from taxation.”

“Wannabe Airbnb investors need to be very careful of UBTI when using their IRA or 401(k) funds,” she said.

Next: The checklist

So let’s run down a brief checklist of the rules for investing in real estate with IRA or 401(k) funds — most of them in place to avoid early-withdrawal penalties, fees, and UBTI.

You Can’t Live There — And Neither Can Your Family

You can’t make your primary residence in a property owned by an IRA. Nor can your parents, siblings, children, grandchildren, grandparents, or other close relatives. If your IRA only has a partial-ownership share of the property, none of the other partial owners can live there either.

“No matter how you paper it up,” Polisano said, “with LLCs or land trusts or whatever, the IRS will see through it. You can’t trick the IRS into letting you buy you or your family a personal residence with tax-exempt or tax-deferred retirement income.”

You Must be a Passive Investor

The law requires that IRA and 401(k) investors take a “hands-off” approach to their investments. No DIY repairs, no personally chasing down rent checks from tenants. Long story short, it behooves you to hire a professional property manager.

“You can pick which property manager you hire,” Polisano said, “but then you have to hand over the keys and all operational responsibilities to them. Otherwise, you could be subject to UBTI.”

All Money Must Stay in the IRA or 401(k)

The purchase price and closing costs for the ownership interest in the property must come entirely from within the IRA or 401(k). If you chip in money out-of-pocket, you may trigger taxes and penalties.

All expenses — property taxes, insurance, repairs, property management fees, etc. — must also come out of the IRA or 401(k). If there aren’t enough liquid assets in the IRA to cover those expenses at any given time, you are limited in your ability to add funds based on annual contribution limits for the type of retirement account you have.

Any income produced by the property must stay in the IRA or 401(k) as well. If you withdraw any of it for personal use, early-disbursal taxes, fees, and penalties apply.

Tax Advantages to Buying Real Estate in an IRA or 401(k)

One of the biggest reasons to invest in real estate is the tax advantage — capital gains, deductible expenses, depreciation, 1030 exchanges, etc. But with an IRA or 401(k), there’s a problem.

“Income within an IRA or 401(k) is already tax-sheltered,” Polisano said. “The taxes are either deferred or waived. Since tax savings are a major selling point for real estate, you have to ask yourself if you wouldn’t do better with a different asset class in your IRA since you won’t actually get that advantage.”

“On the other hand,” she said, “a good Airbnb can be so profitable, it might be worth it.”

What about using a mortgage?

Another selling point of real estate investing is easy leverage through mortgage financing. Again, using an IRA or 401(k) muddies the waters.

“Many lenders won’t lend to an IRA or 401(k),” Polisano said. “They want to lend to a person. A few lenders will consider it … but mortgaging a property in your IRA is an easy way to trigger UBTI.”

So, are Airbnb investors who want to use IRA funds stuck paying all cash with no leverage?

“Not necessarily,” Polisano said. “If they buy ‘subject-to,’ the mortgage stays with the seller. If they foreclose on a mortgage note or a tax lien certificate held by the IRA, the IRA gets the property free and clear.  But once any of our client get into the realm of what they ‘could’ do in circumstances like this, we urge them to consult tax and financial counsel before pursuing such a strategy.”

Finally, rules for operating your IRA/401(k) AirBnB Investment

We’ve covered the broad strokes, so here are some rules to keep your investment compliant.

Repairs and Decoration

The tax code requires you to have a passive interest in the property. This includes your involvement in the repairs and decoration of the Airbnb.

“You can pick the paint color, but you can’t paint the walls,” Polisano said. “You can choose your handyman, but you can’t make the repairs yourself. You can choose the cleaning company, but you can’t clean it yourself. Remember, to avoid UBTI, you have to be as hands-off as possible.”

Liability

Airbnb made its bones offering hosts up to $1 million in liability protection. If you want to limit your liability even more, you might want to hold the property in the name of an LLC, which is owned by the IRA or 401(k). This will protect the other assets in the retirement account. Any extra liability insurance must be paid for with funds from within the IRA or 401(k).

“Again, no outside funds, or taxes and penalties apply,” Polisano said.

Welcoming Guests

The homey touch of a human host is a big selling point for Airbnb users. Unfortunately, this is also potentially asking to be taxed under UBTI.

“I wouldn’t put your name on the Airbnb account or any of the welcoming materials,” Polisano said. “I would use an LLC that owns the property with the IRA as its managing member. It’s not exactly a mint on the pillow, but it’s better than having your retirement funds taxed.”

Hiring a Manager

Ultimately, the easiest way to ensure that you remain passive — and avoid taxes, penalties, and UBTI — is to hand off the asset to a professional Airbnb manager.

Basically, this is just a property manager who specializes in Airbnb listings. This manager can contract repairs and cleaning services, welcome guests, and manage the Airbnb listing.

“With a manager, you stay at arm’s length,” Polisano said, “which is where the IRS wants you with regards to tax-exempt or tax-deferred retirement savings.”

”It’s an extra expense that reduces the profit, but it’s cheaper than a UBTI bill,” she said.

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CamaPlan LLC is a custodian and administrator of self-directed IRA, 401(k), Health Savings, and Education Savings accounts.  Located in Ambler, PA, and serving a nationwide client base, CamaPlan accounts enable investors to allocate capital from their tax-exempt or tax-deferred retirement accounts to real estate, private lending, venture, precious metals and other alternative assets.  Self-directed retirements accounts from CamaPlan provide investors with maximum control over the direction their retirement savings for wealth accumulation, preservation and legacy provision. Learn more at www.camaplan.com.

The above should not be construed as advice or recommendation. We strongly suggest you consult with tax, financial and legal professionals before making any investment decisions.